Request for Guidance Regarding the Relevancy Requirement of the Check-the-box Regulations
| Jurisdiction | United States,Federal |
| Author | By John Miles & Liliana Menzie |
| Citation | Vol. 27 No. 2 |
| Publication year | 2018 |
By John Miles2 & Liliana Menzie3
Selecting the appropriate business entity for a new venture or investment requires thoughtful consideration of legal and tax issues, which often drive the decision-making process. Regulations issued by the United States ("U.S.") Treasury define and classify business entities for Federal tax purposes as corporations, partnerships or disregarded entities, based on several factors4 (the "CTB Regulations"). The CTB Regulations offer unique planning opportunities, since under certain circumstances a business entity can elect its classification for Federal tax purposes.
In the international context, a foreign business entity that is not classified as a "per se" corporation is a "foreign eligible entity" which can elect its classification for Federal tax purposes as set forth by the CTB Regulations.5 The Regulations require that the classification of a foreign eligible entity be "relevant" in order for such an election to be effective. If a foreign eligible entity is not "relevant," such entity must use the default rules to determine its classification once it first becomes relevant.6 Under the CTB Regulations, a foreign entity's classification is relevant:
"[W]hen its classification affects the liability of any person for federal tax or information purposes . . . The date that the classification of a foreign eligible entity is relevant is the date an event occurs that creates an obligation to file a federal tax return, information return, or statement for which the classification of the entity must be determined."7 (Emphasis added.)
As discussed in our paper, it is not clear what constitutes a "statement" where the entity classification must be determined for purposes of the CTB Regulations. The enactment of the Foreign Account Tax Compliance Act8 ("FATCA"), magnified this question and introduced new inquiries, e.g., "Is a Form W-8BEN-E an "information return" or a "statement" that makes such entity relevant for purposes of the CTB Regulations?" The recent Tax Cuts and Jobs Act9 make such questions more relevant than ever as taxpayers and tax professionals explore ownership structures that require a clear understanding of the CTB Regulations.
The authors believe it is important to obtain guidance and clarification on the relevancy requirement on several issues. Specifically, the authors request clarification regarding the following: What is a "statement" for purposes of the CTB Regulations? Is a Form SS-4 or W-8BEN-E an "information return" or a "statement" that makes a foreign eligible entity relevant? If a foreign eligible entity that files a check-the-box election is relevant only on the date the entity classification is effective, is the classification effective thereafter? What are the consequences to a foreign eligible entity that is relevant at the time of making a "check-the-box election", but then ceases to be relevant?
Any new business enterprise requires thoughtful consideration of many business, legal and tax aspects. The decision on the business structure, or choice of entity, is key because the type of entity will determine many of the legal and tax issues for the new business venture. The same applies to an investment project or the holding of personal or business assets.
The process of selecting the appropriate business entity has been influenced significantly by federal tax legislation enacted throughout the years. The most recent amendments to the Internal Revenue Code10 (the "Code"), commonly referred to as the Tax Cuts and Jobs Act11 ("TCJA"), made significant changes to the tax law that will have a substantial impact on choice of entity decisions. For example, for tax years beginning after December 31, 2017, the TCJA permanently reduces the corporate tax rate from 35% to 21% and repeals the corporate alternative minimum tax ("AMT"). Also impacting choice of entity considerations, the TCJA introduces a deduction of up to 20% of "qualified business income" from a passthrough entity, including a partnership, S corporation, or sole proprietorship/ disregarded entity.12
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In addition to legislative changes, regulatory developments can also impact choice of entity decisions. In December of 1996, the Department of the Treasury (the "Treasury") issued final regulations that classify certain business organizations under an elective regime, replacing the then-existing entity classification rules.13 The previous entity classification regime was based upon historical differences under local law between partnerships and corporations. The Treasury and the IRS believed those rules became increasingly formalistic, and opted to replace such system with a simpler, elective approach to entity classification.14The final regulations, known as the "check-the-box" regulations ("CTB Regulations") and first effective January 1, 1997, provide that certain types of organizations are required to be classified as corporations for Federal tax purposes (so-called "per se corporations") and that any "business entity" that is not a per se corporation, including foreign entities, is an "eligible entity" that may choose its classification.15 Absent an affirmative choice, the eligible entity is classified per its default classification. Many legal and tax professionals rely on these provisions for tax planning purposes, however, the interpretation of the CTB Regulations often differs among practitioners.
B. The Check-the-Box ElectionThe election is made by filing Form 8832, "Entity Classification Election", commonly referred to as a "check-the-box election" ("CTBE") with the Internal Revenue Service ("IRS").16 The entity must select its desired classification by checking the appropriate box and specifying the effective date of the election. If no effective date is specified on Form 8832, the effective date will be the filing date.17 However, the effective date specified on the Form cannot be more than 75 days prior to the date on which the election is filed and cannot be more than 12 months after the date on which the election is filed.18 Taxpayers make CTBEs for a myriad of legitimate business and tax reasons.
Since the CTB Regulations became effective, and especially since the CTB Regulations were last substantively amended in the early 2000s, there have been many changes to international reporting requirements of U.S. and foreign individuals and entities. The most notable change is arguably the Foreign Account Tax Compliance Act ("FATCA"), which was part of the Hiring Incentives to Restore Employment (HIRE) Act of 2010. The newest overhaul of the Code, the TCJA, introduced additional rule changes that apply to certain foreign corporations considered Controlled Foreign Corporations ("CFC") under the Code.
As mentioned above, the effect of a CTBE is to change an eligible entity's default classification to a tax classification other than its default classification. For example, a Delaware limited liability company, by default classified as a disregarded entity if it only has one member or a partnership if it has more than one member, could make an election to be classified as an association (taxable as a corporation). Such classification is only effective for Federal tax purposes.19
Although the filing of a CTBE is a fairly simple and straightforward procedure, the planning surrounding the election and the timing requires detailed consideration given the tax consequences of the election. The CTB Regulations describe what occurs, from a tax standpoint, in various changes in classification. For example, if an entity elects to change from an association (i.e., taxable corporation) to a disregarded entity (i.e., wholly-owned eligible entity), the CTB Regulations state the following is deemed to occur: "The association distributes all of its assets and liabilities to its single owner in liquidation of the association."20
The corporation is deemed to liquidate by distributing all of its assets and liabilities to its single owner (the "deemed liquidation"). The tax treatment of the deemed liquidation is determined under all relevant provisions of the Code and general principles of tax law, including the step-transaction doctrine.21
The Regulations provide that the deemed liquidation occurs immediately before the close of the day before the effective date of the disregarded entity election.22 Thus, if an entity classified as a corporation files a disregarded entity election effective on January 1, the deemed liquidation is treated as occurring immediately before the close of December 31.
When dealing with a foreign entity, the CTB Regulations place additional requirements upon the entity in order for a CTBE to be effective, referring to an election by a foreign eligible entity as being "relevant". The subject of this paper is the "relevancy" requirement. As discussed in Part III of this paper, the authors believe guidance and clarification on certain issues is required. For example, whether certain IRS Forms or certifications provided by a foreign entity under FATCA are "information returns" or "statements" which would make the entity relevant under the CTB Regulations.
The Regulations require that the classification of a foreign eligible entity be "relevant" in order for such an election to be effective. If a foreign eligible entity has never been "relevant," such entity must look to the default classification rules to determine the entity's classification once it first becomes relevant.23 The CTB Regulations define relevance under Treas. Reg. Section 301.7701-3(d)(1)(i) by explaining when the classification of a foreign eligible entity is relevant:
"For purposes of this section, a foreign eligible entity's classification is relevant when its...
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